Volatility ETFs Require Perfect Timing To Work

July 11, 2014


Put another way, an average up period for the S&P consists of 0.13 percent up days, during which VXX will lose almost 0.5 percent a day. On the flip side, when the S&P is on a losing streak, it loses about 0.25 percent a day, while VXX rockets up 1.25 percent.

That’s the back-of-the-envelope math, but what about the really nerdy way of looking at it? What if we’re not looking at these longer periods, but just at individual trading days?

# of Days Correlation R2 Beta
Up Days 148 -0.70 0.49 -3.94
Down Days 104 -0.72 0.51 -3.78

This above table splits all of the individual trading days of the last year into the up days in the S&P, and the down days. In case you’ve forgotten your stats classes, there’s mostly bad news in here.

The worst news for VIX fans is that you have a higher negative beta on the days when the market is up than you do on the days when the market is down. That is, in a sense, your “leverage” to the S&P 500. On a day it’s up 1 percent, the beta would suggest VXX is down 3.94 percent. More bad news is that the negative correlation between VXX and the S&P 500 we’re praying for is not only weak (at about -.70) but incredibly unreliable (R-squareds of 0.5 imply essentially a coin flip over whether you should believe the data).

In fact, of the 252 trading days in the sample, there were 25 days when both VXX and SPY were down, and another 25 when both VXX and SPY were up at the same time.

So what to make of all this admittedly complex analysis of a short time period? I come right back to where I’ve always been. VXX works great, but only if you know exactly when to hold it. If you’re enough of a genius to know with certainty when the market is going to be down for multiple days in a row, then VXX is a great leveraged way to capitalize on your superhuman powers of precognition.

If, however, you’re simply nervous and plan on holding it “just in case?” Well, VXX continues to be a terrible way to approach the problem.

(Note: For a deeper dive on when you might be able to eke out some benefit from VIX products, subscribers should check out this month’s issue of the ETF Report.)

At the time this article was written, the author held no positions in the securities mentioned. Contact Dave Nadig at [email protected].


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